- As the Bank of Canada decided to keep interest rates steady, the prime rate stays at 6.25%. The Bank noted that “there are significant upside and downside risks to the outlook for inflation”, which seems to indicate that the future direction of interest rates is unknown at this point. In its previous meeting in July the Bank had hinted at a “modest future increase”.
- The income trust saga continues. The Liberals are floating proposals such as a 10% tax on trusts refundable for domestic investors and allowing new energy trusts to form.
- A column in The Financial Post suggests that Canadian REITs are trading at roughly a 4% discount to net asset value.
- I had an opportunity to meet other Ottawa area financial bloggers at a local Starbucks last night. In attendance were Larry MacDonald of Investment Ideas Blog and the bloggers behind Canadian Financial Stuff, Canadian Money Blogs Reviewer and Dividends Matter. We chatted for two hours about blogging, finances and adventures in the equity markets and we’ve agreed to meet again.
- Jonathan Chevreau and Rob Carrick offer mortgage advice in their respective columns in The National Post and The Globe and Mail.
- Laura Rowley offers four tips for navigating these choppy markets.
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10 responses so far ↓
1 FourPillars // Sep 7, 2007 at 11:14 am
Any good gossip from the meeting?
Don’t worry I won’t tell anyone…
Mike
2 FinancialJungle // Sep 7, 2007 at 12:39 pm
REITs are getting there, but still too expensive IMO. 5-6% yield from the larger REITS just doesn’t cut it when the distribution growth moves roughly in tandem with inflation.
XRE.to may be down around 9% from the peak, but it’s up 55% over the previous 5 years, while distribution only increased 6%.
3 Canadian Capitalist // Sep 7, 2007 at 12:45 pm
FJ: I hold a similar opinion. Still, I suppose a 4% discount is better than where REITs were trading earlier this year.
Mike: I don’t have any juicy gossip to share, unfortunately
4 Dave // Sep 7, 2007 at 1:01 pm
From the Post article: “On average, Canadian REITs are now trading at a discount to their net asset value, creating value for a buyer.”
This sounds like it just might be rubbish. By the time that information hit the newspaper if there really was an opportunity there it would have already have been taken advantage of. Sorry I’m don’t know much about REITs, but what is the net asset value of an REIT based on? The market value of real estate? If so, saying that “Canadian REITs are now trading at a discount to their net asset value” is like saying that Nortel was trading at a discount when it was selling at $60.
5 Canadian Capitalist // Sep 7, 2007 at 2:39 pm
Dave: NAV for REITs is the current market value of underlying assets (malls, apartment buildings etc.) less liabilities. REITs have historically oscillated between a discount and premium to NAVs.
I don’t necessarily agree that any discount is impossible because it will get quickly arbitraged away. REITs are like closed-end funds and unlike ETFs - you can’t exchange shares for underlying assets.
It is fair to argue that NAV of REITs can only fall in the future but the columnist does have a point that the time to buy REITs is when they are trading at a discount. I would hardly call it rubbish.
It is also not true that imperfections in pricing get immediately arbitraged away. It is not unusual for equities to be overpriced or underpriced for a long time.
6 FinancialJungle.com // Sep 7, 2007 at 4:30 pm
Hopefully the current momentum can depress the REITs further by maybe 10% or more, because I love to diversify my portfolio with some REITs. It’s a long shot to expect valuation to drop nearer the 2000 level when investors succumbed to the technology craze.
My opinion is that the NAV itself is inflated, so I wouldn’t buy REITs unless the discount to NAV is substantial. If the distribution is going to grow at the rate of inflation, I want at least 6-7% yield from bellwether trusts, RioCan.
Good luck to all of us
7 Phil S // Sep 7, 2007 at 6:41 pm
I like REITs and they are among the core investments in my various portfolios, both inside and outside of my RSP. The yield is what everybody looks at because they want cash in hand, but many of the highest quality REITs also want to expand, so they don’t have a 100% payout ratio - they are actually reinvesting in their business but still within a REIT structure. In comparison, a REIT that IS paying out 100% (or more) is in danger of getting “whacked” by financial markets if interest rates go up or if liquidity dries up.
For example, RioCan is embarking on a campaign of intensification, essentially building mixed use high rise buildings. This is very capital intensive as they need a lot of money to pay for construction and they set aside some percentage of their funds from operations to pay for this sort of longer-term strategy. Another problem is the “Tax Fairness Plan” - according to the framework of the plan in order to qualify as a REIT, they must be earning “passive” income, meaning that the REIT cannot be engaged in all of this construction activity, for example, if the building is turned around and sold after construction is complete. If you look through the financial statements in most of these REITs, they are all also setting aside cash for “possible future taxes” and they give warnings about possible future restructuring charges due to our morons in government.
Anyways, that is my rant about the whole REIT debacle and the situation that we’re in today when the misguided hand of government got involved where they shouldn’t be. But that’s basically my opinion why in this low interest rate environment, we’re unlikely to see an extremely high quality REIT like RioCan get back up to your 6-7%. It has been a while since I last checked and my memory isn’t so good, but after setting aside all of these buckets of cash to pay for all of these various things, I think RioCan’s payout ratio is only something like 70% of their funds from operations. As a result, if they actually DID pay out 100% of their earnings instead of holding back all of that cash, then you would probably be getting your 6-7% yield.
So, in short, the pricing of REITs are currently not so clear cut these days. You need to look at them as businesses, many of whom are reinvesting in themselves for the future and not as bonds which are yielding whatever %.
In my own humble opinion, I like the fact that the management of some of these REITs are reinvesting in themselves, not just acting as property managers with a bond-like distribution yield. And I resent our government for trying to bust up this structure, especially at a time when governments in other parts of the world are finally just introducing them because they discovered that yield hungry investors can help pump the necessary billions of $$$ of capital into fixing their real estate infrastructure problems.
8 Dave // Sep 7, 2007 at 7:23 pm
“It is also not true that imperfections in pricing get immediately arbitraged away. It is not unusual for equities to be overpriced or underpriced for a long time.”
True.
Although I’m still not sure that “the time to buy REITs is when they are trading at a discount.” If you could predict the future, yes.
9 Phil S // Sep 7, 2007 at 8:29 pm
Regarding the prime lending rate, I have a variable rate home equity line of credit which I tap into whenever I want to leverage up on investments. At the current interest rate of 6.25%, it certainly discourages me from leveraging myself to the hilt and in fact I’ve already sold off a good percentage of my investments to repay it and as of today it’s completely paid off. The law of averages says that historically the stock market provides an 8% return, and in my opinion, a 1.75% return isn’t enough of a return to take on that investment risk. A couple of my friends who do the same thing are also completely unlevered, so my own anecdotal evidence is that the current interest rate should probably be close to the so-called “neutral” rate which neither stimulates nor restricts the Canadian economy.
10 Canadian Capitalist // Sep 7, 2007 at 10:49 pm
Dave: Point taken. I should have phrased it as a “better time”.
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